Mutual funds are a simple and straightforward way to lower investment risks while still maximizing diversification. These investment options offer many advantages and can be a good choice for many types of investors.
Easily diversify your portfolio without having to manage numerous investments.
Pay one expense ratio, not hundreds, while still investing in multiple security options.
Offset your risk across hundreds (or thousands) of securities.
A mutual fund is a pool of money collected from many different investors used to purchase an extensive portfolio of various securities. With the ability to invest in hundreds or thousands of securities at once with a single mutual fund, this type of investment strategy is a practical and efficient way to build a diversified portfolio with pieces like bonds, stocks, and money market instruments.
Many investors choose this type of investment strategy because it has a low investment minimum and offers many benefits to building a diversified portfolio. If you were to build your own portfolio, creating the level of diversification inherent with a mutual fund would be expensive and complicated—but with a mutual fund, you can take advantage of economies at scale.
And because your money is spread out among different securities, there’s a lower risk involved with mutual funds.
Mutual funds set their own list of included securities, which allows investors to choose a type of fund instead of a long list of individual stocks to invest in. Most mutual funds are managed by a portfolio manager who buys stocks and bonds on behalf of the investors, meaning individual investors don’t have to do much of the heavy lifting with a mutual fund. This is important because part of the investment itself involves the manager’s ability to make you money: choose your mutual fund and manager carefully.
With a mutual fund, you’re essentially investing in a portfolio manager’s experience and expertise—not just the fund itself.
The portfolio manager is in charge of the mutual fund’s performance and usually tries to outperform benchmarks like the S&P 500 or other commonly followed indexes. Because an individual actively manages most funds, there are usually a decent amount of fees involved in this type of investment.
Mutual funds pay out investors in two ways: through dividends and capital gains. As an investor, you’re also considered to be a stakeholder, so the way you make money is similar to when you’re an investor in a business.
If your share earns a profit when the stock market closes every day, your mutual fund might pay you. These are usually paid quarterly. With dividends, you can either ask for a check or reinvest those shares back into the fund.
If the investment is sold for a higher price than you originally paid for it, those gains might be distributed to you at the end of the year or paid out when you sell your investment. That’s why most investors tell you to buy low and sell high.
You may have first heard of a mutual fund if you ever had a 401(k) through your employer. Most employer retirement plans utilize mutual funds because they’re pretty straightforward. That being said, there are many types of mutual funds you can invest in as a self-directed investor, with each having its own unique objectives and risks.
These investment objectives can vary from low-risk investments like commercial paper or treasury bills in a money market fund to capital appreciation with equity funds. Let’s compare mutual funds that are the most common:
Equity funds are the most common of all mutual funds. These investments buy stocks from many publicly traded companies and are prone to volatility due to the market. Equity funds are broken down based on what the goals of the funds are. For example, some funds are based on company size, like large-cap funds, mid-cap funds, and end-cap funds. Large-cap funds invest in companies with a market value of $10 billion or more, whereas end-cap funds are made up of companies valued between $300 million to $2 billion. You could also invest in equity funds based on industry or sector, like technology or aviation.
These are fixed-income mutual funds that invest in short-term fixed-income securities. Fixed-income refers to the fact that these focus on investments that pay a set rate of return. This could include things like government or bank debt.
Balanced funds invest in a mix of asset classes to reduce the risk across many types of investments. With a balanced fund, you invest in stocks, bonds, or other alternative investment options. These are designed for investors who want a moderate investment approach with limited risk and equally limited gains.
Index mutual funds work to match the market as opposed to beating it. Because of the lower expectations on returns, they’re usually cheaper in terms of fees and are becoming increasingly popular. Like equity mutual funds, index funds typically vary by the size of a company, the industry and sector, and more.
A fund-of-fund investment is comprised of multiple types of mutual funds—kind of like a mutual fund full of mutual funds. These will include various portfolio managers and even more diversified portfolio benefits. FOF investments spread out the risk even further than traditional mutual funds.
It is essential that investors compare mutual funds by reading the fund prospectus, statement of additional information, and other fund documents to understand each fund’s specific attributes.
To understand the specific attributes of a mutual fund, read the fund prospectus, statement of additional information, and other fund documents.
We encourage our investors to do adequate research or contact a broker/financial advisor, attorney or CPA, to determine if and which types of mutual funds are an appropriate investment.
Once you have determined that a mutual fund is suitable for you, it can be purchased with your Self-Directed IRA or other retirement accounts at Mainstar Trust.
When you use a custodian like Mainstar Trust, you can still receive the benefits of a portfolio manager, who is still in charge of all trading decisions. The custodian simply tracks and holds the securities.